Working Paper: CEPR ID: DP10261
Authors: Lubos Pastor; Robert F. Stambaugh; Lucian A. Taylor
Abstract: We find that active mutual funds perform better after trading more. This time-series relation between a fund?s turnover and its subsequent benchmarkadjusted return is especially strong for small, high-fee funds. These results are consistent with high-fee funds having greater skill to identify time-varying profit opportunities and with small funds being more able to exploit those opportunities. In addition to this novel evidence of managerial skill and fund-level decreasing returns to scale, we find evidence of industry-level decreasing returns: The positive turnover-performance relation weakens when funds act more in concert. We also identify a common component of fund trading that is correlated with mispricing proxies and helps predict fund returns.
Keywords: Active Management; Mutual Funds; Performance; Skill; Turnover
JEL Codes: G10; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fund's turnover (G23) | Benchmark-adjusted return (G12) |
| Higher turnover (J63) | Better performance (D29) |
| Smaller funds and higher fees (G23) | Stronger turnover-performance relation (L25) |
| Common component of fund trading (G23) | Mispricing proxies (G19) |
| Funds trade more when sentiment is high or liquidity is low (E44) | Predicts fund returns (G17) |
| Higher trading activity by other funds (G19) | Greater profit opportunities (G19) |
| Higher trading activity by other funds (G19) | Price impacts that diminish potential returns (F69) |